7/09/2012

Why did China, Europe cut interest rates simultaneously?

The People's Bank of China announced on the night of July 5 that the benchmark yuandeposit and loan interest rate will be cut since July 6, 2012. Almost at the same time,the European Central Bank also announced the reduction of interest rate.

Reduction of interest rates in succession will have a superimposed effect

On June 8, 2012, the People's Bank of China cut the interests rate for the first timesince three and a half years and it again announced to reduce it on July 5, which is thefirst time for Chinese central bank to carry out an asymmetric reduction of interestrates.

Remarkably, the European Central Bank also announced to cut interest rate of 25basis points to 0.75 percent in less than an hour after the Chinese central bankannounced the news. It was the third reduction of interest rates since Mario Draghi waselected the president of European Central Bank and it also is the lowest benchmarkinterest rate in the history of the European Central Bank.

Why the two central banks simultaneously announced the reduction of the interestrates?

Sun Lijian, vice president of the School of Economics under the Fudan University, saidthat this is a coordinated reduction between Chinese central bank and its Europeancounterpart. It is obvious that a superimposed effect caused by simultaneous reductionwill have a positive impact on the world and plays a great role in stimulating theinternational market.

However, in the opinion of Xie Taifeng, dean of the School of Finance under the CapitalUniversity of Economics and Business, China's reduction of interest rate is based onboth China's economic growth situation and the external economic environment and isa comprehensive consideration.

Ba Shusong, deputy director of the Financial Research Institute under theDevelopment Research Center of the State Council, said that recently the majoreconomic entities, whether they are the developed economic entities or the developingeconomic entities, have an economic growth weaker than expected. The synchronousweakening made these central banks return to the slack policy. It can be said thatChina's central bank's reduction of interest rate was launched in the global backdrop.

Rate cuts help inspire market confidence

Xie said that the economic downturn in European countries is an obvious drag onChina and other economic entities and a deceleration also appeared in the export-oriented economy of the developing countries. The simultaneous reduction of interestrates by the two central banks has sent a positive signal and can help stimulateinvestment and demands and inspire market confidence in a downturn period of theworld economy.

"It is necessary for the European Central Bank to cut interest rate," Sun Lijian said.

Sun said that lowing interest rates can greatly reduce the financing cost of the marketand is conducive to saving Spain and Greece. The decline in the financing cost of theenterprises can promote investment and has a positive effect on the maintenance ofgrowth proposed by the Europe. It also can improve the debt repayment capacity of thecommunity as a whole and solve the employment problem.

The experts generally believe that the reduction of interest rate by China's central bankwill also be beneficial to the steady growth of Chinese economy.

Lian Ping, the chief economist of the Bank of Communications of China, said it is anexpected reduction by Chinese central bank and at present the CPI has an obviousdecline. In a short period of time, the commodity prices will continue to go down, whichwill provide a space for regulation and control policy to cut the interest rate.

Interest rate may be further reduced in the future

As for the future direction for monetary policy, Sun believes that as domestic banks stillface a lack of liquidity, the central bank is likely to again lower the reserve requirementratio to release liquidity.

Xie said that China’s monetary policy decisions mainly depend on domestic andinternational economic situations. If this latest rate cut helps increase China’s economicgrowth rate, the country may not further cut interest rates. However, due to the sluggishglobal economy, this rate cut is possibly not enough to halt China’s economicslowdown, and further rate cuts in Europe would not be surprising.